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Top Picks for 2011 (click on company name for report)
C & C Construction
IL&FS Investment Managers
Balkrishna Industries
(click on company name above for report)
Growth Momentum to Continue ....
2010 turned out to be a fabulous year for the Indian Capital Markets and to a very large extent this was possible
due to the massive funds flows coming in from Foreign Institutional Investors which pumped in a record $28bn
during 2010, which resulted in sharp liquidity driving market valuations higher and keeping market indices
moving up sharply. On the other hand the domestic Mutual Fund industry witnessed a record outflow of Rs28238
crs in 2010, despite many mutual fund schemes outperforming the broad markets.
On a annualized basis, compared to last year the BSE Sensex was up by 17% at 20509 levels. The NSE NIFTY
also was up by 18% finally settling down at 6134.50 level.
Sectorially stocks from the Banking, Autos,(CVs, Passenger Cars, Two Wheelers, Tractors and Utility Vehicle
Segments) Auto Components, select Pharmaceuticals stocks and large cap and mid sized IT Services players
gave excellent stock returns, however stocks from the Infrastructure, Construction, Telecoms, and Real Estate
verticals underperformed the broad markets.
The year 2010 will also be remembered for the large PSU IPO’s like Coal India, Manganese Ore India Limited and
several PSU Banks which offered the retail investor an opportunity to make excellent stock returns from such
IPO’s making it a win win situation for both the government and small retail investors thereby mproving the
market sentiment from the small retail investors.
Going ahead in 2011, we believe that the PSU divestment will continue to gather momentum as several large
PSU IPO’s are planned in the first quarter of 2011 and this will definitely be an interesting investment theme
going ahead provided IPO valuations are right and there is adequate upside profit opportunity for the incoming
retail investors.
So, how does the year 2011 look forward and how is this going to be different from last year?
Our view on the Markets in 2011 – Cautiously Optimistic
Broadly on the positive side, corporate earnings by way of advance tax going by the Q3 numbers, are going to
be positive. Second, from all that we hear and we see, the allocation of foreign capital flows towards India will
continue to be very positive, and particularly on the back of quantitative easing 2, We think it is only going to
increase and certainly not decrease.
On the negative side, there are two things. we believe that this whole government impasse is not a good thing
because everything stops and there are no reforms that can happen if the impasse continues. Second, issue is
of about governance issues which has been a big dampener and it certainly doesn’t exude confidence in our
markets. Third is input prices and crude prices going up is not very good.
India still remains among the few growth markets globally and steady corporate earnings growth also augers
well. So, net-net, outlook for 2011 is going to be positive. We don’t think it’s going to be runaway rally, but also
we also do not expect markets to show a major down side in the near to medium term. We expect markets to
witness consolidation in the H1 of 2011 and thereafter move up gradually on strong FII flows driving the markets
upwards.
Markets need a strong political message from the ruling Congress Govt –
2010 will also be remembered as a year of political scams wherein the 2G Telecom scandal and the Common
Wealth Games Scam clearly exposed the governments inability to protect public interests at large. While corruption
has always been a bane for India, in the last 6 months the number of such scandals and the scale of corruption
by political names alleged to be involved have all shocked the nation.
We believe that the congress government at the centre has to provide fast track solutions to such scams and
should use this opportunity to clean the system and send a strong political message to all that its means to do
clean business. If done quickly and correctly we believe that this would significantly re-rate our markets.
Events to watch out for –
Euro Zone issues and China Tightening
US Recovery in 2011
Rising Crude Oil Prices
Higher Interest rates and rising inflation which could impact earnings growth negatively
Going ahead the Union Budget for this year and government finances
On the Index a return of 10-15% would be a reasonable estimate over the next one year. For FY12, a 15% to
17% earnings growth looks easily manageable and we expect that PEs should be sustained at an average level
of around 16x. Overall we expect the Sensex and Nifty to a close the year at around 22000-23000 levels and
6800-7000 levels. We believe that investors adopting a stock specific approach would reap good dividends rather
than following a index based investing approach in 2011.
Sectors where we remain Positive: Autos, Capital Goods, Power Equipments, Construction, Infra, Metals,
Fertilizer and Agri. Related, Pharma, IT and Banks.
Sectors where we remain Negative: Real Estate, Telecom and Cement.
In terms of the macro economy, 8.9% GDP for three consecutive quarters running is what we are coming from,
but there are building in pressures of inflation and a lot of people are raising the red flag over that the global
commodity prices are not helping at all, nor are food prices. Hence although the growth momentum will be
maintained, GDP growth is not going to be as strong as what we saw this year.
We have two three reasons. One is that base effects are going to start hitting us just like they were helping us
this year. Second is interest rates are moving up and inflation is the key theme, so we are starting to see interest
rates move up and that at some point will start hurting. Third is that investment demand has slowed down a bit,
projects are not coming on as fast as one has been expecting, there has been variety of reasons which are
tending to slow this down. However it is not like India is going to slowdown dramatically, but it’s not going to be
as fast as what we saw this year.
Oil prices are going up which from India’s point of view is probably one of the toughest things to watch out for.
So, we will have growth which again is not going to fall off dramatically, but we are not going to see a repeat of
earnings that we have seen in FY11. So, on the profit margin front, is not good for India in 2011 as it was in 2010.
Burgeoning Price Levels – Pressure on Central Bank
After remaining in double digits for five successive months, year-on-year headline WPI inflation declined to 8.8%
in August 2010 and further to 7.5% in November 2010. Consumer price inflation for industrial workers and rural/
agricultural labourers softened to single digit rates from August 2010, after remaining in double-digits for over
a year. In addition, inflation for non-food primary articles such as raw cotton, raw rubber and minerals rose
sharply during the year.
Though inflation has moderated, inflationary pressures persist both from domestic demand and higher global
commodity prices. The pace of decline in food price inflation has been slower than expected due largely to
structural factors. There is a risk that rising international commodity prices will spill over into domestic inflation.
Going forward, rising domestic input costs for the manufacturing sector combined with aggregate demand pressures
could weigh on domestic inflation, increasing the risk to RBI’s projection of 5.5% by Mar 11.
Tax Collections in line with Expectations
The government’s kitty swelled by 18% to Rs 296121 crore from direct taxes till the mid of Dec month in the
current fiscal, driven by robust corporate tax payments, including advance tax.
During the nine-month period this year, corporate tax grew by 21.3% and personal income tax rose by 16.2%,
as compared to the corresponding period last year. Revenues from indirect taxes also jumped up 42.3% to
Rs.207756 crore in the first eight months of the current fiscal, led by 67 % higher collection from custom duties.
The government has budgeted Rs 430000 crore from direct taxes and Rs 313000 crore from indirect taxes for
the current fiscal. But it needs a higher revenue growth than budgeted, having committed an additional expenditure
of more than Rs 75,000 crore through two supplementary demands for grants, wiping out the windfall gain of Rs
1,00,000 crore from auction of 3 G.
The governments subsidy bill is also expected to cross the budget estimates, following the spike in global
commodity prices. The fertilizer ministry has projected a revised demand of Rs 82245 crore as against the
budgeted Rs 52837 crore, citing hardening international prices of key inputs and imported fertilizers. The petroleum
ministry could also seek extra funds to compensate oil companies for higher losses incurred in selling fuel at
below cost as global crude prices have risen to over $90 a barrel. However with economic growth showing
impressive resilience, the government is confident of reaching its tax collection targets, both in the direct and
indirect tax segments.
Current A/C Deficit at 2.9% of GDP
India’s current account deficit has widened further during the second quarter of the fiscal year at $15.8 billion as
against $ 9.2 billion of the same period of previous year, primarily on account of higher imports and lower net
invisibles, whereas for the first half of the year it doubled to $ 27.9 billion as compared to $ 13.3 billion of
H1FY10. This is largely on account of economic recovery and larger payments overseas for certain services such
as travel, business and financial services and investment income.
With the imports rising at a greater pace than exports, trade deficit expanded to $ 35.4 billion for the Q2FY11 as
against $29.6 billion of Q2 FY10. For the period of Apr-Nov 10, it stood at $81.7 billion as compared to $68.4
billion of the same period of previous year with 26.5% YoY growth of exports and 11.2% rise in imports for the
month of November. With this, the current account deficit stood at 2.9 % of GDP of last fiscal and the continuation
of the same trend may take it to higher than 3%.
Outlook on Commodities –
Gold -
Gold price has rallied more than +27% so far this year, marking the strongest rise since 1979 when price more
than doubled. There are 2 main reasons driving the metal higher: Sovereign crisis in the European periphery and
QE by the Fed. These 2 factors will continue to support gold next year. In 2Q10, gold made a record high of 1266
as Greece was facing insolvency and the euro was threatened to be disintegrated. At that time, gold was trading
in sync with US dollar, signaling extreme risk aversion. In early November and early December, gold also surged
to all-time highs of 1424 and 1432 respectively amid resurfacing of sovereign concerns in the 16-nation region.
Despite Gold’s 27% increase in 2010, it remains 35% below its inflation adjusted high of January 1980 which was
$2,300/oz. Although we have concerns that the current rally appears to be a momentum driven bubble, it may
well continue through 2011.
As long as the US Federal Reserve is engaged in efforts to stimulate the US economy with rock bottom interest
rates and quantitative easing programmes, gold will find favour among investors. Eurozone debt default is
another cause of concern for wary investors, while Chinese investment demand is also growing strongly but
quietly in the background. Gold will rise probably in 2011, too, to break new records and target $1600 at COMEX.
We are still far away from euphoria. Although gold has attracted some first time investors prompted by fear and
searching for a safe haven for their capital, gold is far away from being a crowded trade.
Crude Oil –
Crude oil has underperformed the commodities space in the most recent rally, despite the fact that the benchmark
U.S. crude oil price averaged 15% higher than the beginning-of-year consensus of $71 per barrel; and around
5% higher compared to the previous Energy Information Administration’s outlook for $78.67 per barrel. The
price of Crude oil at $91 stands at a historic juncture. The demand picture continues to be mixed. Despite the
moderation in the Chinese economy, crude oil imports are still higher than in recent years. In contrast, U.S. oil
demand is well below historical averages. Crude oil inventories in the U.S. are still running above historical
averages, which have capped oil prices. But broad U.S. dollar weakness and gradually improving risk appetite
should support oil.
On the negative side are the renewed concerns on the euro zone peripheral debt situation, interest rate hikes in
Asia, and some lingering risk aversion, as well as increase in supply from OPEC (Iraq, Kuwait and Saudi spare
capacity) and non–OPEC (gas liquids, Brazil) sources.
Also, as and when there is a decline in inventories to below the five-year average, the liquefied natural gas story
will start playing out. Going ahead the prices of crude oil are likely to average around $86 per barrel in 2011.
Investment Strategy –
We continue to believe that the India long term story continues to remain robust despite temporary global and
local hiccups. Here it would be interesting to know that the Sensex which was around 3972 level at the beginning
of the decade closed 2010 at 20510, a gain of 416% clearly signifying the fact that investors who remained
invested benefited significantly whis is more important than timing investments in the stock markets.
On the global front, economic conditions continue to be challenging, with the US struggling with unemployment,
high deficits and huge debt. The European markets have also continued to struggle with bailout packages announced
in 2010 and indications are that recovery here will take some more time. The Chinese economy also continues to
chug along with robust growth but the challenge here is to slow down the economy as inflation concerns are
growing.
We hence believe that the domestic economic environment will be challenging in 2011 and expect the markets to
stay in a consolidation mode in the H1 wherein the markets are likely witness the impact of high inflation, higher
crude prices, tight monetary policy and political uncertainty given the recent spate of events. In the H2, we
expect markets to be driven by strong macro economy numbers and steady growth seen in corporate earnings.
Investors should use market corrections to accumulate quality stocks on market declines.
We continue to remain bullish on sectors like Autos, Capital Goods, Construction, Power Equipment Pharma and
Banks . Infrastructure stocks have not done well in the last 6-8 months and with increased government spending
they should also attract investor attention in the months to come.
In the large caps stocks we like TCS, HCL Technologies, BHEL, L&T, BGR Energy, Tata Motors, M&M, Bajaj Auto
and Ashok Leyland.
In the mid cap segments we like JB Chemical & Pharma, Diamond Power and Infra, Supreme Infra, C&C
Construction, Balkrishna Industries and Glenmark Pharma which we believe offer good quality businesses at
reasonable valuations from a 12 month perspective.
In conclusion we wish all our customers.....
a Happy & Prosperous new year
and
Profitable year ahead in 2011
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